Subprime auto-loan delinquencies rise to 2019 levels: A dive into subprime lending and securitization

The increase in crimes is not because of unemployment, but because of taking big risks, expecting big profits and getting slapped like in 2019.

By wolf richter For wolf street,

Defaults on subprime auto loans have spiked to stimulus-fueled lows during the pandemic, when borrowers were stuck on their auto loans with money from stimulus checks and additional unemployment benefits, and by not making mortgage payments because they were unable to meet eviction restrictions. due to nonpayment of rent, and had entered their mortgages into a forbearance program. Most of it is gone now, and the money is gone, and the subprime delinquency rate is on the rise.

Subprime Delinquency Rates Rise, Still Down From 2019 Good Times,

In December, the default rate for subprime auto-loans 60-days-and-older in asset-backed securities (ABS) rated by Fitch Ratings rose to 5.7% of total auto loan balances. The record in the 21st century was set in August 2019, The Good Times, at 5.9%.

Prime-rated auto loans are in pristine condition,

According to Fitch Ratings, delinquent rates for “prime” rated auto loans are near a record low of 0.2%. During the worst moment of the Great Recession in January 2009, the major crime rate rose to 0.9%, which is still very low. Prime auto loans are a low risk, low yield business.

Subprime rated auto loans and asset-backed securities (ABS).

Auto loans are rated subprime for several reasons The bond is rated “junk” (BB+ and below): The risk of the borrower not repaying the loan is very high.

Investors buy them because they are paid higher yields to compensate for taking on those higher risks. Subprime auto loans, like junk bonds, are a high-risk business with potentially high profits and high losses.

Subprime loans on used vehicles come with interest rates of 15% to 20% on average, depending on how deep they are in subprime, according to Experian. Investors are willing to take higher risk to get these kind of juicy yields.

Most subprime lending is provided by a group of specialized lenders. Most subprime auto loans are packaged in asset-backed securities (ABS), which investors such as bond funds and pension funds buy for their high yields.

ABS are structured with equity tranches and the lowest rated tranches bear the loss first. As the losses mount, higher-rated tranches start to suffer. The top-rated tranche of a subprime-auto-loan ABS, probably rated “AA” (my cheat sheet) Credit Rating of Corporate Bonds), will take damages only if the lapse causes serious damage to the ABS.

Tranches with higher credit ratings offer the lowest yields, and investors who are more risk-averse tend to buy them. Low-rated trenches are bought by adventurous cowboys. And the lowest installment is usually maintained by the subprime lender that originated the loan — essential skin in the game, which is one reason smaller specialty lenders can go belly-up.

Subprime lending has been around for decades and is riddled with abuses and scams. Some subprime loans come with interest rates so high that they practically guarantee that the loans will default. Some subprime lenders take on significant risk in their underwriting practices.

Sometimes regulators break down, and so there are settlements and penalties that subprime lenders consider part of the cost of doing business. And from time to time, specialty lenders go belly-up because something didn’t pan out. Risk taking is motivated by the high yield, and the ease with which the vehicle can be bought and sold at auction.

According to Fitch Ratings, auction sale proceeds covered 40% to 50% of defaulted loan balances on subprime auto loans (the “recovery ratio”) in the years prior to pre-owned vehicle price increases beginning in 2020. it was done.

But as the prices of used vehicles increased from late 2020 to early 2022, the recovery ratio increased. According to Fitch, for subprime auto loans, the recovery ratio is set to exceed 70% in 2021, far higher than any prior record. Used Vehicle Prices Still Too High But Now Falling, So the recovery ratio is coming down and will come back around 40% to 50%.

Subprime, a small portion ($210 billion) of total auto loans and leases ($1.52 trillion),

Subprime loans primarily focus on used vehicles, which have low amounts financed and make up only a small portion of the total outstanding auto loans. So here are some basics about the magnitude of subprime auto loans based on Experian’s Q3 report (it defines “subprime” as a credit score of 600 or less):

  • Only 13.7% of the total outstanding balance of auto loans was subprime.
  • Only 15.8% of the total number of loans and leases originated in the third quarter were subprime.
  • only 5.2% of the number of new vehicle Loans originated in Q3 were subprime.
  • But 22.4% of the number of used vehicle Loans originated in Q3 were subprime.
  • Average amount of used vehicle loans originated in Q3: $28,506
  • Average amount of new vehicle loans originated in Q3: $41,665.

Total auto loans and leases outstanding in the third quarter totaled $1.52 trillion, according to New York Fed data. With 13.7% of the outstanding balance being subprime, the total amount of subprime-rated auto loans is approximately $210 billion, the majority of which is owned by investors who purchased ABS.

Risk-taking in good times drives crime, not unemployment.

Note in the chart near the top of the page: Crime rates fell from the beginning of 2010 to the spring of 2011 – during bad times, the unemployment crisis, resulting in dialed back risk aversion in new lending.

As you can also see in the chart, as the Fed continued to lower interest rates in 2011 investors went on a wild chase for yield, and risk increased across every asset class, including subprime auto loans. This spirited risk-taking led to an increase in the subprime delinquency rate during those years, and in August 2019 Good Times set a 21st century record.

A group of small specialized subprime auto lenders owned by private equity firms collapsed into bankruptcy during these good times in mid-2019. that i covered at the time,

This August 2019 record – and the bankruptcy of specialty lenders – occurred when the job market was hot and unemployment was very low. This happened because these smaller lenders were taking on bigger risks over the years to get a bigger yield, in a world where yields had become scarce.

Despite this high delinquency rate and the collapse of some smaller lenders in 2019, the auto lending business remained profitable for lenders who managed their risks appropriately.

So the increase in crime in 2019 was not due to the employment crisis, but due to increased risk taking.

Now the same thing: the increase in crimes is not due to any kind of unemployment crisis or whatever – the the job market is historically tight And wages are rising – but taking risks from 2020 to 2022.

Risk-taking was further encouraged by the surprise jump in used vehicle prices when many of these loans were made, with lenders deluded into thinking they would receive very high recovery rates for the defaulted loans. And he achieved a record high recovery rate for some time. But they are coming down now.

The loss of subprime loans in ABS that Fitch tracks remains below 2019, despite crime rates rising to 2019 Good Times levels. In December, the subprime auto loan annual net loss index by Fitch rose to 8.3%, but it was still down significantly from 9.7% in December 2018 and 9.4% in December 2019.

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